Fighting smart strategy options for telecoms operators

The following individuals were interviewed for the study: l Okan Alper, division head for Internet and community, Turkcell l Hannes Ametsreiter, CEO, Telekom Austria l Francis Deprez, se

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© The Economist Intelligence Unit Limited 2010

The analysis in the report is based on interviews with senior executives of telecoms network operators and independent industry experts, as well as on desk research The following individuals were interviewed for the study:

l Okan Alper, division head for Internet and community, Turkcell

l Hannes Ametsreiter, CEO, Telekom Austria

l Francis Deprez, senior vice-president of group strategy and policy, Deutsche Telekom

l Sertan Eratar, divisional head, Turkcell

l Colin Giles, global head of sales, Nokia

l Michael Hecker, vice-president of strategy and corporate development, MTS

l Bertrand Kan, global head of TMT, Nomura

l Chris Lane, head of group strategy, Vodafone

l Guy Middleton, head of corporate communications, 3 UK

l Jan Ogren, vice-president of network planning, Ericsson

l Tushar Rao, analyst, Capgemini

l Scott Richardson, strategy adviser, Clearwire

l Russ Shaw, head of mobile, Skype

l Morten Karlsen Sorby, head of business development, Telenor

l Lin Sun, independent analyst on China’s telecoms market

l Tim Whitley, chief strategy officer, BT

l Richard Windsor, analyst, Nomura

The author of the report was Iain Morris and the editor was Denis McCauley Our sincere thanks go to the interviewees for sharing their insights with us

May 2010

© The Economist Intelligence Unit Limited 2010

3

The rising importance of the Internet and data services, combined with the gradual decline of the

much older voice business, is creating threats and opportunities for telecoms network operators in almost equal measure While data traffic revenue could more than compensate for the decline of voice, the networks needed to support them are costly to build In the mobile broadband market, levels of usage are also putting a huge strain on capacity and threatening profitability

Perhaps the biggest threat to operators, however, comes from the so-called over-the-top players that the former’s own networks have allowed to flourish Although these companies, through their online services, are attracting new users to the networks, they often play a bigger role than operators would like The worry is that customers will develop closer relationships with the Internet companies than with operators, and that the latter end up being seen as little more than a utility service—a “dumb pipe” Were that to happen, the commoditisation of services would accelerate and revenue would come under even greater pressure Network-based operators do not often disappear, but a combination

of low revenue-growth prospects and large, unavoidable capital outlays needed to deploy generation networks will spell real financial trouble for many players

next-A central premise of this study is that the spectre of a “dumb pipe” future is overstated for all but the most hidebound of operators The latter have numerous assets that should allow them to compete—and partner—effectively with Internet companies But operators urgently need to take action on several fronts For a start, they need to work out how they can build a compelling customer experience, either in partnership with Internet companies or working against them Given the likelihood that service prices will continue to fall, they also need to explore ways of restraining capital intensity and bolstering efficiency as they build out newer networks At the same time, they must consider adapting their pricing practices so there is a closer connection between usage and retail rates—and do this without scaring off customers Meanwhile, they have to think about ways of defending their traditional voice business without simply blocking Internet companies Finally, they have to take a lead role in developing new opportunities in industries like energy, healthcare and publishing

Arguably no operators have yet found the “grail”—the business model which will enable them to achieve all the above, ensuring a profitable future even while the threats from Internet players and other non-traditional competitors multiply But there are no shortages of experience and best practice

Executive summary

for operators to call upon Based on interviews with a range of senior operator executives and industry experts, as well as extensive desk research, the Economist Intelligence Unit has identified five sets

of strategy options, or “strategy typologies”, which operators should explore in seeking the optimal business models to take them forward:

Smart pipe: By partnering with Internet companies rather than competing against them, operators

can bring their own unique capabilities to content and applications development and stave off the threat of commoditisation A smart-pipe strategy makes sense in markets where Internet companies are well-established Even where the latter have less power, for example in Russia, operators such as MTS successfully partner with some online firms while also competing aggressively in the content and applications market

Efficient pipe: By carefully monitoring competition and demand, efficient-pipe operators are

controlling the pace of next-generation network deployment They are also using technologies such

as femtocells, and sharing networks with rivals, to lower their capital and running costs Greater automation of business processes could bolster profitability for numerous telecoms organisations, and especially those—like Germany’s Deutsche Telekom—that remain encumbered by their origins as state-owned monopolies

Pricing pioneer: Astute operators are examining new pricing models that better reflect actual network

usage and guard profitability Sophisticated schemes based on time-of-day usage and speed could meet with particular success The UK’s Vodafone has been trialling such a scheme in Spain Depending

on the regulatory environment, charging content companies for providing a higher-quality service could give rise to an entirely new wholesale opportunity

Defender of the realm: An extension of the smart-pipe strategy, this approach recognises that

partnering with, rather than blocking, innovative Internet companies is one of the best means of attracting and retaining customers For example, while mobile operators generally fear the impact of third-party VoIP (voice-over-Internet Protocol), one or two have realised there is more to be gained from partnering with VoIP providers than blocking them which, among other things, makes operators unpopular with their own customers The UK’s 3 has been able to attract more profitable customers through a deal with Skype, while Verizon hopes a similar arrangement will help it to capture a bigger share of US smartphone customers

Transformer: This strategy focuses on identifying new revenue opportunities in areas such as energy,

healthcare and publishing Deutsche Telekom, for example, is targeting €1bn in sales from “intelligent networks” by 2015 These opportunities look most attractive to operators having both business-to-consumer (B2C) and business-to-business (B2B) operations, and especially those that have already developed an IT-services capability Operators should take a leading role in demonstrating the benefits

of smart grids, e-healthcare and e-publishing, for example, to their customers

© The Economist Intelligence Unit Limited 2010

5

“On the one hand, we’ve never had so many opportunities On the other, we’ve never faced so

many risks.” Hannes Ametsreiter, CEO of Telekom Austria, the country’s largest network operator, neatly sums up the position of operators emerging from the recent recession A surge of interest in broadband services, particularly in the mobile-phone world, should create enormous opportunities for the companies that own and run the networks Mobile data revenue alone is forecast to rise from US$257bn this year to US$420bn in 2014, according to Pyramid Research, an analyst firm Yet all that growth cannot happen without enormous investment—all the while that operators’ core voice businesses are going into decline

The biggest threat to operators arguably emanates from the Internet players that broadband networks have allowed to flourish In the old voice-only days, ownership of the networks equalled full control of the service delivered to customers But the rise of the Internet has brought about a disintermediation Operators now see many companies competing to provide a service over their lines and build a relationship with their customers As broadband has developed, a handful of these

0 100 200 300 400 500 600 700 800 Mobile data Mobile voice

2014 2013

2012 2011

2010

companies have grown into some of the most powerful brands on the planet Although online content still generates far less revenue than data access, many operators fear becoming “dumb” commodity pipes They are concerned about having to bear the cost of rolling out next-generation networks And they worry about losing touch with their customers.

The purpose of this study is to examine how telecoms operators—offering fixed services, mobile services or a combination of both (“integrated” operators)—will seek to address these threats over the next half-decade Based on lessons learned by companies in different parts of the world, it also identifies potentially successful operator strategy typologies

This paper argues that operators still have an opportunity to compete with the Internet giants in particular markets It shows that they can avoid being tagged as “dumb pipes” by collaborating with those companies and contributing their own unique skills and resources to application development The study also demonstrates that there are various means by which operators can become more efficient, and argues that investments in infrastructure can be contained, while carefully managed adjustments to pricing systems can safeguard the profitability of mobile broadband services

© The Economist Intelligence Unit Limited 2010



Operators appear less tormented by the prospect of being dumb pipes than in years past Some of

the biggest, for example, are no longer fiercely protective of their own Internet portals Chris Lane, head of group strategy at Vodafone, a UK-headquartered mobile operator, says its portal, Vodafone Live!, was created partially because there were no third-party alternatives for getting users onto the mobile Internet, and that it might not even exist ten years from now Yet Live! was once seen as the archetypal “walled garden”, by which operators hoped to prevent customers from using third-party services Other operators, meanwhile, have stopped trying to be actual content providers “We used

to employ a lot of people involved in generating or buying content,” confirms Guy Middleton, head

of corporate communications for 3, the UK’s youngest mobile operator “Now we focus on Internet communications apps and getting the most relevant Internet apps working well on phones.”

Few operators have entirely given up on having a presence for content and applications But instead

Smart pipe

Mobile websites' share of UK mobile Internet users

(%)

Note "Share of users" refers to the percentage of users who have accessed these sites on a mobile phone during each year.

Source: Morgan Stanley, The Mobile Internet Report, December 15th 2009.

0 10 20 30 40 50 60

0 10 20 30 40 50 60

WikipediaAmazon.com Webmails Microsof

t eBay

Yahoo!

NokiaBBC Google Carriers

0 10 20 30 40 50 60 70 80 90

0 10 20 30 40 50 60 70 80 90

Carrier

s

Yahoo!

WikipediaMicros

oftYo

ubeWebmails

Facebook

Nokia

BBCGoogle

Key points

n Instead of struggling to compete with “over-the-top” players, many operators see deeper partnerships with these companies as the answer

n Partnering should capitalise on the operator’s value to an Internet company

of struggling to compete with “over-the-top” players—industry shorthand for Internet firms delivering their own video and other content over operator networks— many see deeper partnerships with these companies as the answer (See chart on the previous page for an indication of how quickly operators’ Internet presence has declined in the UK.) “We put in a lot of effort and had good usage and lots of turnover, but at the same time it didn’t necessarily generate much margin or prove to be critical to our customers,” says Mr Middleton of 3’s online music business He now believes there is greater value in partnering with the likes of Spotify and others.

To proponents of the operator portal, this approach might appear to be admitting failure and accepting a role subservient to over-the-top players But partnering with the most exciting Internet companies is, at the very least, a means of attracting new customers to data-based tariffs More importantly, partnering should capitalise on the operator’s value to an Internet company Nokia, for example, is willing to share revenue from sales on its Ovi online store with operator partners because it realises that “operator-integrated billing” eases the payment process for many consumers, according

to Colin Giles, Nokia’s head of global sales Moreover, Internet companies agree with operators that the best services are made possible by collaboration “The experience we’ve built with Verizon is better than the over-the-top one,” says Russ Shaw, head of mobile for Skype, a VoIP provider “Working with it and being deeply integrated into the handset is another step forward in terms of customer experience.”Two operators focused on enhancing this customer experience are Vodafone and Deutsche Telekom, Germany’s dominant telecoms service provider Once seeming intent on preventing customers from using services other than its own, Vodafone is now trying to enable the use of applications across different third parties—such as Facebook, Google and Windows Live Messenger—through 30, its suite of mobile Internet services Deutsche Telekom’s My Community works in a similar way, allowing a customer to choose a contact before deciding whether to communicate via a call, text, online chat or

case study MTS and the three-way pipe

Michael Hecker, vice-president of strategy and corporate

development for MTS, Russia’s largest mobile network operator,

describes the company’s strategy as a three-pronged affair: “smart

pipe, content pipe and dumb pipe”

“Smart pipe” involves partnering with other companies to

provide the best possible user experience to the customer One

example of that is a deal with a Russian social-networking site called

Odnoklassniki (translated as “classmates”), which gets about 12m

users daily “That has brought a huge increase in data access usage

and revenue, as well as customer loyalty, because with an MTS phone

a customer has the Odnoklassniki experience on mobile for the first

time,” says Mr Hecker

“Content pipe” extends MTS’s role in the value chain It operates

a portal called Omlet.ru that takes a share of revenue from the

sale of music and videos to customers MTS aims to make Omlet

ru the iTunes of Russia and the Commonwealth of Independent States (CIS) Helped by its retail presence of over 3,000 stores, the operator has a more powerful brand than Apple’s in this region Moreover, because Omlet.ru is loaded with Russian content, it may hold greater appeal to the typical Russian consumer than a more international, English-language storefront such as iTunes “Another advantage we have is control of the billing and payment relationship

in a country where credit cards are not widely used as a payment tool,” notes Mr Hecker

Sales on Omlet.ru helped MTS to earn Rb13.2bn (US$21m) in content revenue in the third quarter of 2009—exceeding even the Rb10.2bn (US$325m) it made from data-traffic revenue (although much of the content revenue was generated by the sale of ring-back tones and other add-on services) Even so, as MTS expands its networks in Russia, particularly after recently gaining permission

to provide 3G (third-generation) services in Moscow, the “dumb pipe”, access-revenue part of the business may be the one that matters most

© The Economist Intelligence Unit Limited 2010

9

1 TV delivered over

Internet protocol, the

communications technology

that underpins the Internet

social network These are services an Internet company could not provide and a user may highly value

“Either an over-the-top player has had to create a closed environment, as has Apple, or a customer has had to commit himself to one social network, and we’re saying that’s not necessary,” says Francis Deprez, senior vice-president of group strategy and policy at Deutsche Telekom

It is not only by providing services across multiple platforms that operators can make a different type

of contribution to the customer experience Deutsche Telekom has been introducing technology that allows services to be run across multiple devices, for instance allowing IPTV1 content to be screened on

a smartphone “As customers store more content on our digital network, and as they use it across more devices, they will be more inclined to stick with us as a provider,” maintains Mr Deprez

Not another app store

Operators have not entirely stopped competing against over-the-top players The “app store”

(applications store) offered by Apple has sparked countless imitations, including from operators Vodafone’s 30 service has an app store at its very heart, and earlier this year Vodafone clubbed together with other companies to unveil the Wholesale Applications Community—an operator-led initiative to challenge the dominance of Apple Bertrand Kan, global head of TMT at investment bank Nomura, is sceptical about the operators’ move “The operators do not have a good track record in competing on such technological innovation,” he maintains

Yet as competitors operators also have considerable strengths Mr Ametsreiter of Telekom Austria believes that intense co-operation in the app store market could produce the biggest platform in the world, working across multiple handsets and operating systems and with a large community of developers Morten Karlsen Sorby, head of business development for Telenor of Norway, also notes that operators often store more information about customers than is typically available to firms such

as Google If privacy concerns can be overcome, that information could be used to create more tailored and relevant applications and advertising Also, operators are used to dealing directly with customers

“Google doesn’t know anything about proper retail and after-sales service,” stresses Mr Lane of Vodafone

In markets with a rich and distinctive culture, where US software giants are not as relevant, national operators may also have a big advantage over Internet companies For example, the local knowledge of Turkcell, Turkey’s largest mobile provider, is helping it to build an app store of particular relevance to the domestic consumer “Google is a great company but it doesn’t know the Turkish market intimately as we do,” claims Okan Alper, division head for Internet and community for Turkcell

Notwithstanding international business concerns about China, and Google’s high-profile withdrawal from the country, cultural idiosyncrasies mean that Chinese operators can play a bigger role in

applications than operators in other parts of the world, notes Lin Sun, an independent analyst “Apple needs to work hard with China Unicom [one of the country’s three main mobile providers] to produce a Chinese version of the app store,” he says “Otherwise the potential value of the iPhone will fall.”Elsewhere, competing with the likes of Google and Apple will be far more difficult Although they must partner with these brands as well as software companies, operators also need to prevent any one organisation from becoming so powerful that it is able to dictate terms, as Apple has sometimes appeared to do Ultimately, however, there is a major consolation should they fail “Even if our customer relationships weaken, the need for infrastructure will definitely be there,” says Mr Sorby of Telenor

While many hate to be called dumb pipes, operators have excelled at running very large and

profitable businesses out of providing basic connectivity Yet due to their origins as state-owned monopolies, many of the world’s biggest operators labour under significant constraints, says Nomura’s

Mr Kan “When products commoditise you need to have free rein to control costs and headcount and drive your bottom line,” he says “A lot of operators cannot easily do that.”

Besides being so encumbered, operators are also being forced to spend heavily on network infrastructure to serve the demand for increasingly sophisticated services Beyond the upfront investment, the operational savings that can be realised from the use of new network technologies are very significant, believes Mr Kan Recent data, for example, suggest that there is a cost-per-megabyte reduction of 50% in moving from 3G to HSPA (high-speed packet access, a so-called 3.5G technology) and another 50% reduction in going from HSPA to LTE (long-term evolution, sometimes considered

a 4G technology) Yet operators need to explore ways to contain the initial expense of some of their network investments and extract more efficiency from their businesses

Efficient pipe

Mobile broadband cost of ownership in comparison with WCDMA

(Total cost of ownership per gigabyte as % of WCDMA)

Source: Nokia Siemens Networks.

Note Assumes 10Mhz bandwidth, 10 year depreciation, and a greenfield case MIMO = multiple input, multiple output.

0 10 20 30 40 50 60 70 80 90 100

0 10 20 30 40 50 60 70 80 90 100

LTE HSPA+ MIMO

HSPA+

HSPA WCDMA

Key points

n Operators need to explore ways to contain the initial expense of their network investments and extract more efficiency from their businesses

n Business process modernisation, closer integration of fixed and mobile units, sharing of network components and using advanced technologies in high-demand areas can all help improve efficiency

© The Economist Intelligence Unit Limited 2010

11

2 In a mobile, or cellular,

network, “core” and

“backhaul” refer to those

parts of the network

connecting the caller in the

originating cell to the user

in the destination cell

“You don’t have to

provide nationwide

[fibre] coverage

right away to make

it work.”

Francis Deprez, senior

vice-president of group strategy and

policy, Deutsche Telekom

One option is further modernisation of business processes According to Mr Deprez of Deutsche Telekom, the entire telecoms industry lags other sectors of the economy when it comes to automating areas like customer care and order management He believes that next-generation IT (information technology) systems will help Deutsche Telekom to raise its operating margin (before depreciation and amortisation) to 35% by 2012, from its 2009 level of 31%

Closer integration of fixed and mobile units can also help operators to realise savings Deutsche Telekom’s One Company project in Germany and eastern Europe is intended mainly to ease the cross-selling of fixed and mobile products But by moving to shared systems for customer relationship management and other IT functions, the operator also aims to lower its costs Mr Deprez says other savings can be realised by using shared core and backhaul network infrastructure.2 Russia-based MTS is also hoping to realise US$5m of cost synergies by merging its core and backhaul networks with those

of Comstar-UTS, a local fixed-line operator in which it recently took a 51% stake

There is little that can be shared, however, in the “last mile” to the end-user—the costliest part

of the network to build Mr Deprez acknowledges that as service prices continue to fall, capital expenditure must be kept under control “The only way to do that is to be a lot more demand- and competition-driven,” he says Deutsche Telekom is not only focusing the roll out of its fibre-optic network on areas where there is strong competition from cable-TV providers, but is also examining the level of customer interest in bandwidth-rich offerings in particular neighbourhoods “You don’t have

to provide nationwide coverage right away to make it work,” states Mr Deprez

Operators are taking a similar approach in the mobile sector By using more advanced technologies to supplement older ones in high-demand areas, they can limit the roll out of next-generation networks,

case study BT, fibre and IPTV

Tim Whitley, chief strategy officer of BT, says the investment case

for the company’s fibre-optic network plan is based on the need

for higher bandwidth in the market, as services like catch-up TV,

video-on-demand and multi-room HDTV (high-definition TV) take

off Yet, for many years the company resisted a rollout, prompting

criticism from industry observers that the UK would end up lagging

its European peers on broadband capability

A major factor in this change of approach has been the

willingness of Ofcom, the UK regulator, to grant BT more control

over the wholesale pricing of its fibre-optic network than it enjoys

with copper Another has been the activity of Virgin Media, a cable

rival, which has upped the pace and marketing of its own high-speed

network deployment Both developments led to a commitment from

BT in 2008 to spend £1.5bn on rolling out a fibre-optic network to

about 0% of UK homes

Not all observers are convinced by the plan, however For a start,

the project mainly involves building fibre only as far as the street

cabinet, not the home If, in future, the demand for bandwidth forces BT to be more ambitious, an upgrade would make the overall project more expensive than if BT had built to the home in the first place Second, the Conservative Party has indicated that, should

it win the forthcoming general election, it will force BT to make its underground ducts available to rival infrastructure providers Such a move would weaken BT’s investment case considerably

The biggest concern, perhaps, is about revenue potential A rich

TV service would help, yet BT Vision—the operator’s IPTV offering—

is dwarfed by the TV services of Sky, a satellite operator, and Virgin Media BT is collaborating with UK broadcasters on Project Canvas—aimed at creating an open platform that allows content companies to provide services for the TV This could certainly attract new customers to broadband, and challenge the pay-TV incumbents, but the revenue model remains unclear Indeed, Mr Whitley believes that Canvas will help to ensure that the enormous consumer benefits

of Internet-connected TV are not restricted to paying customers, and that BT Vision would be able to offer bundles that are extremely competitive in comparison with existing pay-TV providers No wonder it is so fiercely opposed by Sky